Week In Review – January 22, 2012

"What I think we fear is rapid, pronounced, and uncontrollable changes to ourselves, and because of this we have a form of personality inertia - something that resists rapid change." - Simon Travaglia

Amazing how quickly things can change isn't it?

Markets had quite a strong week as earnings season continued, with most stock indices having their best start to a year since 1987. As I have written about over the past two weeks, a dramatic change appears to have occurred in terms of a repricing in of inflation expectations, and a sudden shift away from fearing deflation following last year's incredible volatility. The "Winter Resolution" idea I had been writing about since the end of December following the Summer Crash and Fall Melt-Up appears to be playing out, whereby correlations and volatility are dropping, and a trend (up) is emerging.

I understand many are scratching their heads, wondering why markets are suddenly behaving as if Europe no longer matters. It's as if we've entered another universe and the fears of last year have completely gone away. As many of you may be aware, our focus at Pension Partners is on identifying the conditions under which markets move up or down. The most important condition from an asset allocation standpoint is purely what inflation expectations are at any moment in time. When inflation expectations are rising, that means the conditions favor equities over bonds ("risk-on"), and when falling, i.e. during deflation fears, bonds likely do better than stocks ("risk-off").

Following the first week of January, our ATAC (Accelerated Time And Capital) models sensed a sharp return of inflation expectations and positioned our clients' managed accounts into equities. Much like a ketchup bottle that you keep shaking and that out of nowhere suddenly coats the plate, investors are sensing that the end of the world is not right here, right now and that enough policy response may have occurred to avert Lehman 2.0. One of the strengths for us about our weekly model is that we can pick up on those junctures when markets dramatically change opinion likely faster than more traditional investment firms.

The nice thing about this rally is that the right things are working. Unlike the melt-up move in October of last year, this time around emerging markets and high beta small-cap stocks are showing a real pickup in strength after having some nasty declines in 2011. In addition, bond yields are rising at the same time and we are very nicely moving away from panic levels in Treasuries. This is very encouraging as it means money is beginning to position more aggressively into risk, with the potential for bigger returns to come as a result. Should this continue, this is likely the ideal kind of environment where our ATAC strategies can shine brighter than other active management approaches. I will be writing about this theme in my next piece for Marc Faber of the Gloom Boom and Doom Report, due out next month.

I fully understand the hesitation that most have regarding this market. The two biggest counterpoints I see people express is that volume is low, and bullish sentiment is high. It is incredibly important to understand that unless traders and money managers have the assets to express their bullish view, none of those reasons hold any merit. The amount of outflows from equity funds last year and inflows into bond funds means there is a lot of capital on the sidelines to deploy. And since most like to buy past prices, that money likely really goes back into stocks when higher highs are made.

In terms of Europe, it appears as though Greece will avoid default based on recent reports, and that bank risk has dramatically fallen following the European Central Bank's Long Term Refinancing Operation in December. This makes us quite encouraged that the storm has passed and that this is precisely the right kind of environment to put money to work in. And while austerity certainly slows down growth, France, Italy, and Spain are already starting to think about taking pro-active growth initiatives to counter an economic slow-down.

Its very important to realize that the problem with making long-term forecasts is that implicit in a long-term view is "all-else-being-equal." The future is too dynamic for all-else to be equal, and things do change. This is why for us at Pension Partners, our ATAC models are designed to be run weekly to take advantage of the long-term through a rolling period of short-terms. And for now, the short-term looks pretty good.

On another note, I encourage you to listen to my most recent radio interview on the Wall Street Shuffle at http://feedproxy.google.com/~r/thewallstreetshuffleshow/~3/khI6_pCbKFM/20120117-Seg5.mp3 at around the 4 minute mark. I am working on a regular spot with them to discuss our views. In addition, Ed Dempsey and I will be co-hosting Bloomberg Rewind for the hour this Wednesday alongside Matt Miller. Feel free to tune in and provide us feedback. In addition, I will begin contributing articles next week to EmergingMoney.com, which is run by Tim Seymour of CNBC's Fast Money.

For those wondering how we're performing real-time, please get in touch with us any time during normal business hours. We are in the midst of our GIPS (Global Investment Performance Standards) year-end review and until that is finalized, we will not be able to update our data on our website. We expect that to be done by the middle of February.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.